The local equity bull has become tired and higher than expected interests rate hikes, a decline in the growth rate of corporate profits and the inevitable sub prime fall-out mean that 2008 may be a relatively unexciting year for equity returns. This is according to Alwyn van der Merwe, director of investments at Sanlam Private Investments (SPI) the company within Sanlam which looks after investments for high net worth individual investors.
But Van der Merwe, who was speaking at a year-end market review session in Johannesburg today, believes there are still pockets of value to be found on the Johannesburg Stock Exchange (JSE). “The banks look cheap but it is too early to venture back into retail shares. Although construction shares have generally performed spectacularly well, we expect continued support from strong profit growth in the sector.”
He said that the macro environment had become more challenging. “A number of the factors which gave energy to the bull market in 2006 and 2007 have started to turn. While equities are not yet in bubble territory, they are hardly cheap. What is a concern, though, is that the risks are building for negative surprises in terms of the growth in corporate earnings. Short-term interest rates have risen much faster and higher than was widely expected. This has had a negative impact on consumer spending and has begun to take its toll on the profit growth of retail stocks and, more specifically, on credit retailers.
“Consumer shares are feeling the impact of higher interest rates on the demand for their goods and even local manufacturers are starting to feel the pressure. Manufacturing production declined in the third quarter,” said Van der Merwe.
Commodities are on firm footing due to growth in China, India and the Middle East but prices are at their highest levels in real terms in the past 50 years. “Despite the robust outlook for growth in these regions, our view is that the upside for a wide range of commodities is limited from these inflated levels. In the absence of positive price surprises from commodities it is unlikely that commodity shares will continue their stellar performance. Another concern regarding profit growth is evidence of increased labour costs that are eating into the profit margins of corporates.”
Global equity markets came under serious pressure when it became clear that the ‘born-to-shop’ mentality of the US consumer was not enough to counter the negative impact of the sub prime crisis and the associated credit crunch. Numerous indicators suggest that consumer spending in the US is on the backfoot. South Africa has not escaped the direct and indirect consequences of this event. “We will continue to see the direct consequences of the crisis in company results of international financial institutions well into the first quarter of 2008 and the indirect fall-out is likely to manifest itself as the year evolves.”
Turning to specific sectors and stocks which could deliver above average returns in 2008, Van der Merwe said that SPI favoured the under priced financials sector. “Banks look very cheap currently. Despite the current negative sentiment in the sector, these are solid stocks with good prospects and this should swing market sentiment in their favour.” Standard Bank and Firstrand are stand out stocks according to Van der Merwe.
The sizeable infrastructural spend announced by government – which will continue to have positive economic consequences well past World Cup 2010 – means that stocks like Murray & Roberts have remained house ‘darlings’ for Sanlam’s private client boutique. Although many market commentators believe that M&R could well be ‘priced for perfection’, the share might well continue to provide investors with a good return. However, it would be dangerous to apply a shot-gun approach to the sector. Shares exposed to the residential property sector are likely to experience a slow-down. Van der Merwe cautioned that the residential building pace was slowing rapidly. “The rate at which building plans are being passed has declined rapidly and the associated rate at which new houses are being built has followed the trend.”
SPI believes that one of the big losers over the last two years, the credit retail sector, might look interesting from a value perspective. “However, it is too early to buy these shares as the macro-environment will continue to provide headwinds to the sector. An old stalwart Remgro remains in favour - a stock which SPI describes as defensive, offering a decent discount, having quality assets and being likely to benefit from imminent corporate action.”
Van der Merwe concluded that SPI would actively seek out pockets of value for its client base of high net worth individuals and that it did not believe that the decrease in average returns would not result in 2008 delivering any great returns on equities.
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